Analysis of Home Depot
The Home Depot was formed in 1979 by Bernie Marcus and Arthur Blank in Atlanta, Georgia. Home Depot virtually revolutionized the do-it-yourself home improvement industry in the United States almost overnight. The two entrepreneurs opened their stores which were no frills warehouses. In 1998 the average Home Depot carried 35,000 products. Products varied from well known national brands to propriety Home Depot brands.
Home Depot held its IPO in 1981 and listed on the New York Stock Exchange three years later under the ticker – ‘HD’. Home Depot reached $1 billion in sales in 1986. Sales of $20 billion were reached in 1997 making them the fastest growing home improvement retailer with an average annual growth in sales of 119% during said period.
It is important to note that as Home Depot has grown so quickly, it has been able to garner significant concessions in prices from suppliers. Home Depot has also been able to establish and successfully execute a market saturation strategy coupled with low prices and high service. Being able to execute on these three pillars has been the hallmark of Home Depot’s strategy and will carry the company into the future.
As Home Depot continues to expand, the cost of prime real estate will rise as they compete head to head with their main competitor, Lowes. Also tied to the market saturation strategy, Home Depot stores may realize a cannibalization of sales when a nearby store opens its doors.
While expanding internationally, Home Depot will be careful to pay close attention to local building customs, laws, and regulations.
Maintaining solid returns on investment and financial health will be a primary concern. More interestingly, Home Depot plans on investing significant amounts of money in their human capital to maintain their consistently high marks in customer service and knowledge of home improvement projects.
Five Forces Model of Competition
As the world’s largest home improvement retailer, Home Depot’s competition runs the gamut of lumber yards, specialty interior stores that concentrate on one aspect of the home, i.e. kitchens, lighting, flooring, etc. Home Depot’s competition is also embodied in other such retailers as: Sears, Ace Hardware, Frank’s Nursery, and Lowes.
Home Depot’s competition (except Lowes) primarily focus on one aspect of their expansive product offerings. For example, Sears would specialize in selling Craftsman tools to Home Depot’s offering; likewise Frank’s Nursery competes directly with Home Depot’s garden center.
Lowe’s Companies is Home Depot’s largest competitor. Home Depot and Lowes have very similar product offerings and large warehouse formats. In many major markets Lowes and Home Depot stores go head to head both vying for the patronage of the do-it-yourself customer.
Home Depot maintains relationships with many suppliers that stock Home Depot stores with over 30,000 different products. Although Home Depot has a significant amount of suppliers they are still able to force them into offering price concessions due to the fact that Home Depot makes up a large portion of the supplier’s sales. These concessions have gone a long way in driving down the cost of home improvement as well as further increasing Home Depot’s margins and competitiveness with Lowes and others in hotly contested markets.
At the time of the case, Home Depot has 3 distinct customer segments.
Since the company’s incorporation, they have been primarily focused with the do-it-yourself (DIY) customers. These customers are non-professional consumers interested in doing their own home improvement projects.
More recently, Home Depot has also begun to redefine the market in which they operate. This redefinition has opened up the buy-it-yourself and professional customer segments to Home Depot.
Specifically the buy-it-yourself customer segment are those consumers that like to pick out the materials being used in their homes, but want a professional to install them.
Moreover the professional customer segment that Home Depot now associates itself with are contractors, electricians, plumbers, landscapers, etc. This group has been able to get Home Depot to offer products in larger quantities due to their larger scale projects.
Substitute products pose a grave threat to many companies. However, Home Depot does not have many substitutes. People will always be houses and the desire to improve one’s home is one that is ageless.
A substitute to Home Depot’s in store home improvement classes is the vast resources of the internet. With a few clicks of a button, a customer can find “How To” instructions as well as plans for various types of projects.
Another substitute that the Home Depot should be aware of is the purchase of new homes. With new homes people will have a much lower need to purchase home improvement supplies.
New entrants to the home improvement will find it very difficult to compete directly with Home Depot and or Lowes. A company that is new to the market will face a vast difference in economies of scale that they may not necessarily be able to overcome. Also new entrants will be faced with trying to compete head to head with Lowes and the Home Depot or they will be forced to specialize in a certain product category.
The barriers to entry include the following considerations: large product selection, highly trained employees, large startup capital, prime real estate, strong regional recognition, and unwavering customer loyalty.
Home Depot has many competitive strengths that make them a very difficult company to compete against. Home Depot’s strengths include:
Well known brand name
Extensive product offerings
Ability to grow
Home Depot’s business model, the first of its kind in the home improvement industry has revolutionized the way customers shop for home improvement products. Their business model is simple. Sell home improvement products and services to DIY, BIY, and professional customers in huge spacious warehouses that boast a wide variety of products with sales associates that are educated and knowledgeable about home improvement (case). This is all done with low prices as the primary driver.
The Home Depot name has become synonymous with home improvement. This association has been forged over a long time of being number one in customer’s minds when it comes to home improvement. Home Depot’s orange aprons, low prices, knowledgeable associates, and warehouse like stores have all contributed to a very strong brand image.
It is no secret that if you want anything having to do with home improvement the first place to go is Home Depot. Home Depot has distinguished itself as the home improvement warehouse that has what you are looking for when it comes to home improvement. Their extensive product lines have made Home Depot the one stop shopping in home improvement.
Since the beginning, Home Depot has demonstrated its desire to become the largest home improvement retailer in the world. Home Depot has planned on growth rates of 21%-22% growth rates in the number of stores over the next several years. By 2003 Home Depot plans on having over 1900 stores (case).
Counterbalancing the strengths of Home Depot, it also has a couple of key weaknesses that need to be addressed.
Growth has both a blessing and a headache for Home Depot. As the have expanded aggressively into new markets, they have seen their operating expenses rise in direct proportion with their growth in revenue. While this is would be expected in most instances. This means that Home Depot is not capitalizing on economies of scale in logistics and distribution provided to them by their market saturation strategy.
Because of Home Depot’s size they have some interesting opportunities available to them.
With a solid foothold in North America, Home Depot will set its sights on other world markets to further expand and spread its business risk across many diverse world markets. Expansion will be the primary focus for growth into the year 2000.
Home Depot has an opportunity in the global sourcing of their products as their scope and reach becomes global. Sourcing from other countries may significantly grow their gross margin.
Home Depot’s Service Performance Improvement (SPI) program is due to deliver huge paybacks in productivity of night team workers. Other IT projects pose great opportunities to increase efficiency, decrease costs and further increase margins.
Because of the competitive nature of the retail industry, Home Depot’s success depends on price, store location, customer service, and wide product selections. In each market that Home Depot serves there is a plethora of specialty home improvement stores that have the potential to cutting into Home Depot’s market share (Data monitor).
Home Depot’s overlap with primary competitor, Lowes, poses a potential threat. In the minds of consumers, Home Depot may be seen as interchangeable with Lowes which would in turn decrease customer loyalty. Also when a Lowes enters a market that is only served by Home Depot, Home Depot’s sales have a tendency to decrease by up to 15% (Data monitor).
As Home Depot and Lowes continue to compete head to head in primary markets and both continue their strategy of market saturation, the awareness of US market saturation becomes a very real possibility. According to Data monitor, “The US home center potential is valued at approximately 3,500 stores. With Home Depot and Lowes opening a combined 300 stores a year, the industry could reach saturation in the next few years.”
Industry Key Success Factors
In the competitive home improvement industry there are several key success factors to be considered:
Relative Price of Products
Use of Technology
The price a company charges for its products and services is vital to the successfully competing. If a company prices itself way below the competition in order to undercut the existing prices in the industry and is unable to recoup lost margins, then it will suffer as much as it would have if they priced their products way out of the reach of their target customer.
Brand image in the home improvement industry is vitally important because you do not want to lose customers to your competition. Home Depot has positioned its brand more towards men and professionals as Lowes targets the women of the family with their cleaner, better lit stores.
The strength of a company’s distribution network is of utmost importance in the home improvement industry. The company that has the most stores and can get the most product out to the customer (profitably) is the industry winner.
The financial might of a particular competitor allows them to invest in programs that would potentially save them money, or grow their sales. A financially stable company is critical in an industry where growth is the name of the game.
Competitive Strength Assessment
In the competitive strength assessment, the industry key success factors were used to analyze the competitive strengths of Home Depot, Lowes and Ace Hardware. Please see exhibit 1 for the actual strength assessment.
From the competitive strength assessment we have learned that Home Depot is the best positioned company in the home improvement industry. Lowes is not far behind Home Depot. The major difference between Home Depot and Lowes was Home Depot’s advantage in financial strength and possessing a powerful brand.
Ace Hardware is a non-contender; however they had far more stores than Home Depot in 2000. The main difference is the fact that one Home Depot store has a much higher volume of sales than a typical Ace Hardware Store. Most of the other points were a wash, as Home Depot won in all but one of the most important categories.
The Home Depot at the end of 2000 stands on rock solid financial footing. On a whole they are poised to make a successful run into the next millennium. Home Depot’s net revenues have grown 208% between FY 1995 and FY 2000. This is amazing growth. Home Depot continues its market saturation strategy which consistently grows their net revenues. Please see exhibit 3.
Home Depot’s growth in net earnings over the same period has been 284%. This is fantastic. The money that the firm is retaining as profits is outpacing the total amount being brought into the company. This is indicative of a company that is realizing economies of scale in their operations and increased brand awareness.
From the ratio analysis in exhibit three we see that in 1998, Home Depot was leading Lowes in all of the profitability ratios listed except earnings per share. Lowe’s EPS equaled $1.37 to Home Depot’s $0.73. This is in part due to the fact that Lowes is significantly more leveraged with debt than Home Depot. This is displayed in the debt to equity ratio.
It is important to note the activity ratios when talking about an industry where competitors need to carry a lot of inventory to effectively compete. Home Depot leads in total asset turnover as well as inventory turnover. Home Depot sells out of their stock 6.71 times per year as opposed to Lowe’s 5.91 times.
Overall from the analysis it is safe to say that in 1998, Home Depot was on solid financial ground compared to their primary rival, Lowes. Since they are in the heart of their growth, I would imagine that they will continue to have significant gains in economies of scale and further translate those savings to the bottom line.
From the in depth analysis of Home Depot and its primary competitors, it seems that Home Depot is positioned well to move into the next millennium. Financially, Home Depot is very sound which is good considering they will need vast amounts of capital to continue growth. Home Depot also appears to be realizing investments from IT as well as operational efficiencies provided to them by SPI.
Home Depot seems to show some weakness in their ability to collect from customers as evidenced in the average collection period (exhibit 3). Perhaps a reworking of the credit policy is in order. They should also be careful not to grow out of control due to imminent market saturation and overall industry slowdown.
Bensinger, Ari. (June 15, 2000) Retailing: Specialty [Electronic Version] Standard & Poor’s Industry Surveys
Datamonitor, (2004, October) Company Profile: Home Depot. Retrieved December 1, 2004 from www.datamonitor.com
Home Depot 10-K 1995-2000. (n.d.) Retrieved December 1, 2004 from LexisNexus
Home Depot Annual Report 1995 – 2000. (n.d.) Retrieved December 1, 2004 from www.homedepot.com
Lowes Annual Report 1998 – 2000. (n.d.) Retrieved December 1, 2004 from www.lowes.com
Exhibit One – Competitive Strength Assessment
Key Success Factor Importance Weight Home Depot Lowes Ace Hardware
Relative Product Price 0.30 8/2.4 7.5/2.25 5/1.5
Brand Image/Recognition 0.20 9/1.8 7/1.4 3/0.6
Executive Management 0.05 8/0.4 8/0.4 5/.25
Use of Technology 0.10 7/0.7 8/0.8 3/0.3
Distribution Network 0.20 9/1.8 8/1.6 10/2.0
Financial Resources 0.15 9/1.35 7/1.05 5/0.75
Sum of Important Weights 1.00
Weighted Overall Strength Rating 8.45 7.5 5.4
Exhibit Two - Strategic Group Map
Exhibit Three - Financials
**Numbers in Millions of dollars
1995 1996 1997 1998 1999 2000
Net Sales 12476 15470 19535 24156 30219 38434
Cost of Merchandise Sold 8991 11184 14101 17375 21614 27023
Gross Profit 3485 4285 5434 6781 8605 11411
Selling and Store Operating 2216 2783 3521 4303 5341 6832
Pre-Opening 51 52 54 65 88 113
General and Administrative 230 269 324 413 515 671
Non-Recurring Charge (note 8) 104 0 0
Total Operating Expenses 2498 3105 3900 4885 5944 7616
Operating Income 986 1179 1533 1896 2661 3795
Interest Income (Expense):
Interest and Investment Income 28 19 25 44 30 37
Interest Expense (note 2) -35 -4 -16 -42 -37 -28
Interest, net -7 15 9 2 -7 9
Earnings Before Income Taxes 979 1195 1534 1898 2654 3804
Income Taxes (note 3) 375 463 597 738 1040 1484
Net Earnings 604 731 937 1160 1614 2320
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